FUNG BUSINESS INTELLIGENCE CENTRE www.lifunggroup.com PMI Quarterly on China Manufacturing IN THIS ISSUE : PMI points to growth stabilization Headline PMI 2 Output 5 New orders & new export orders 7 Backlogs of orders 10 Stocks of finished goods & major inputs 11 Purchases of inputs 11 Input prices 14 Output growth moderated. New orders index and new export orders index indicate stable domestic demand and recovering external demand. Backlogs of orders stayed in the contractionary zone. Destocking activities continued. Purchases of inputs decelerated. Upstream cost pressure eased. Imports remained weak. Employment index has fluctuated within a narrow range. Suppliers delivery slowed down. Chinese manufacturers have become more optimistic. Imports 17 Employment 19 Suppliers delivery time 21 Business expectation 22 Helen Chin Tel: (852) 2300 2471 helenchin@fung1937.com The Fung Business Intelligence Centre 10/F, Li Fung Tower, 888 Cheung Sha Wan Road, Hong Kong Tel : (852) 2300 2470 Fax : (852) 2635 1598 E-mail : lfdc@lf1937.com http://www.funggroup.com
1. PMI points to growth stabilization After peaking in October and November, China s manufacturing PMI fell for three consecutive months to 50.2 in February. The February reading was the lowest in eight months, indicating growth moderation in China s manufacturing sector and economic activities in general. The index rebounded slightly to 50.3 in March. (See exhibit 1) It is noteworthy to recognize the discrepancy by size of enterprises. The PMI of large enterprises stayed above 50 over the past three months, while the PMIs of small enterprises and and medium enterprises remained in the contractionary zone throughout January to March. (See exhibit 2) In our view, the latest trend of the headline PMI points to diminishing hard landing risk and a stabilizing economy, though the March improvement is too marginal to indicate a significant recovery. Output continued to grow in a steady manner. Index readings for new orders, new export orders and imports were all higher in March than in the previous month, indicating strengthening domestic and foreign demand. In particular, the new export orders index gained 1.9 pts and returned to the expansionary zone in March, after having stayed below the 50-mark for three months. The purchases of inputs index also rebounded from 49.4 in February to 50.3 in March, suggesting better business confidence as manufacturers increased their purchases. Meanwhile, the index reading for stocks of finished goods showed gradual increases over the past three months; the destocking cycle has largely run its course. The input prices index fell all the way from 52.6 in December to 44.4 in March, which bodes well for manufacturers profit margins in coming months. We believe this set of PMI data is comforting to the policymakers. With the economy stabilizing and inflation easing, emphasis will continue to be placed on structural reforms. Having said that, the government remains vigilant about possible slowdown of the economy. We therefore expect the government to prioritize reform programs which do not only boost long term productivity but also stimulate near term growth. Policy measures recently announced include social housing, tax relief for small and micro enterprises and speeding up railway construction. We also anticipate more policies on urban infrastructure, environmental protection and energy conservation, IT infrastructure, industrial upgrading, service sector development, financial reform, health care reform and government reform. We forecast a mild rebound in growth from 7.4% yoy in 1Q14 to 7.6% yoy in 2Q14 and 3Q14. Going forward, we expect the headline PMI to fluctuate between 51-53 in 1Q14. In the coming months, industrial activities will be supported by public investment, still-robust domestic 2
consumption, recovering foreign demand and restocking activities. Meanwhile, Chinese manufacturers will continue to face difficulties such as tough export environment, foreign protectionism, spiraling labour cost, restricted access to credit and RMB appreciation. Overall, we expect the industrial production (VAIO) growth to hover around 9-11% yoy in 2Q14. Exhibit 1: Headline PMI, April 2012 to March 2014 Exhibit 2: PMIs of large enterprises, medium enterprises and small enterprises, January to March 2014 3
Exhibit 3: Headline PMI and sub-indices, January 2005 to March 2014 Exhibit 4: Headline PMI and all sub-indices, January to March 2014 4
Exhibit 3 shows that the headline PMI moderation over the past three months was mainly attributed to the marked fall in the new orders index (which weighs 30% in the computation of the headline PMI) and the output index (weighs 25%). Among the 11 sub-indices (i.e. excluding the suppliers delivery time index), only 3 (output, new orders and business expectations) stayed in the expansionary zone over the past three months. The indices of backlogs of orders, stocks of finished goods, stocks of major inputs, imports, input prices and employment remained below 50 throughout the past three months. (See exhibit 4) China s manufacturing PMI has so far done a satisfactory job in predicting economic growth. Exhibit 5 plots the quarterly real GDP yoy growth rates versus the monthly PMIs since its inception. It could be seen that the PMI demonstrates a fairly good track record of forecasting the growth trend of the economy at least over the next few months. Based on this chart we forecast a mild rebound in real GDP growth from 7.4% yoy in 1Q14 to 7.6% yoy in 2Q14 and 3Q14. Overall, we forecast the real GDP growth in FY14 to be at around 7.5% yoy. Exhibit 5: Headline PMI and real GDP growth, January 2005 to March 2014 2. Output growth moderated Output growth eased in 1Q14, corresponding to the slowing demand growth. The output index slid from 53.9 in December to 53.0 in January and 52.6 in February, before edging up to 52.7 in March. However, the output index has stayed well above the 50-mark, showing that output 5
growth was still robust. (See exhibit 6) Exhibit 7 shows that the deceleration in production growth in the past three months was mainly attributable to the moderating growth of new orders instead of destocking activities. It is noteworthy that the stocks of finished goods index has been rising for three consecutive months, gradually approaching the neutral 50-line. The pace of inventory liquidation has slowed. Output may grow strongly later when manufacturers have finally run out of their inventories or regained confidence to restock. Exhibit 6: Output index, April 2012 to March 2014 Exhibit 7: Output, new orders and stocks of finished goods, January 2005 to March 2014 6
Exhibit 8 demonstrates the correlation (with some lags) between the output index and the yoy growth of value-added of industrial output (VAIO). The VAIO growth has largely trended downward since October last year. Looking ahead, we expect the VAIO growth to hover around 9-11% yoy in 2Q14. In the coming months, industrial activities will be supported by public investment, still-robust domestic consumption, recovering foreign demand and restocking activities. Meanwhile, Chinese manufacturers will continue to face difficulties such as tough export environment, foreign protectionism, spiraling labour cost, restricted access to credit and RMB appreciation. Exhibit 8: Output index and industrial production growth, January 2005 to March 2014 3. New orders index and new export orders index indicate stable domestic demand and recovering external demand The new orders index fell to an eight-month low of 50.5 in February, before improving marginally to 50.6 in March. In any case, the index has stayed in the expansionary zone for eighteen months, showing that domestic demand has been stable. The new export orders index had stayed below the 50-mark throughout December to February, before it gained 1.9 pts to reach 50.1 in March. External demand has stabilized and started to recover. 1 (See exhibit 9) Exhibit 10 shows that the new orders index generally leads industrial production by about 2 to 3 months. The new orders index suggests stable growth of industrial production in coming months. Again, the projection based on the new orders index is that the VAIO growth is likely to hover 1 We have received a number of enquiries on this point. The new orders index covers both domestic orders and export orders. That is to say, the manufacturers are not asked to differentiate between domestic orders and export orders when filing in the questionnaires. 7
around 9-11% yoy in 2Q14. Exhibit 9: New orders index and new export orders index, January 2005 to March 2014 Exhibit 10: New orders index and industrial production growth, January 2005 to March 2014 Exhibit 11 plots the new export orders index against the yoy growth rates of China s exports. The correlation between the two is fairly high, with the new export orders index leading the export yoy growth rate by about 3 months (except in early last year, when the export figures were greatly inflated by fake exports). With the new export orders index rising above the critical 50-mark again, we have become more optimistic over China s export outlook. Besides, from exhibit 12 we can see that the new export orders index has been strongly correlated to the external economies, especially the developed economies. The OECD composite leading 8
indicator 2 has continued to trend upward, which confirms our relatively optimistic outlook for China s exports. All in all, we forecast China s export growth to improve to 4-7% yoy in 2Q14. Exhibit 11: New export orders index and export growth, January 2005 to March 2014, China Customs Exhibit 12: New export orders index and OECD composite leading indicator, January 2005 to March 2014, Organization for Economic Cooperation and Development 2 The OECD composite leading indicator, compiled by the Organization for Economic Cooperation and Development, is designed to provide early signals of turning points (peaks and troughs) between expansions and slowdowns of economic activity, and covers Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United Kingdom and United States. 9
4. Backlogs of orders stayed in the contractionary zone The backlogs of orders index has stayed in the contractionary zone since April 2012. The index rebounded from 45.1 in December to 45.7 in January, but then dropped again to 45.1 in February and 44.8 in March. (See exhibit 13) We expect it to remain below 50 in the near future, as indicated by the apparently very high correlation between the sub-index and the headline PMI, together with the moderating trend of the headline PMI. (See exhibit 14) Exhibit 13: Backlogs of orders index, April 2012 to March 2014 Exhibit 14: Backlogs of orders index and headline PMI, January 2005 to March 2014 10
5. Destocking activities continued Inventories of both finished goods and major inputs continued to shrink in the past three months. After falling to the recent low of 46.2 in December, the stocks of finished goods index rose all the way to 48.3. The pace of inventory liquidation has slowed. Output may grow strongly later when manufacturers have finally run out of their inventory of finished goods and start a restocking cycle. The stocks of major inputs index has remained in the contractionary zone since February last year. In the past few months, the index has been fluctuating within the narrow range of 47.4 to 47.8. (Exhibit 15) Exhibit 15: Stocks of finished goods index and stocks of major inputs index, January 2005 to March 2014 6. Purchases of inputs decelerated The purchases of inputs index fell all the way from its recent peak of 53.6 in November to 49.4 in February the first time in eight months that the index dipped below the critical 50-mark. However, in March, the index gained 0.9 pts to 50.3, returning to the expansionary zone. (Exhibit 16) A number of factors affect the purchasing activities of manufacturers, among which the amount of new orders received by manufacturers has been the most important factor. Exhibit 17 plots the 11
purchases of inputs index against the new orders index. The correlation between the two sub-indices is very strong. This is intuitively easy to explain as manufacturers usually need to purchase extra inputs to cope with new orders. We expect to see continuous increase in purchases if the rise in new orders persists. The purchasing activities also reflect business confidence. Exhibit 18 shows the association between the purchases of inputs index and the entrepreneur confidence index (ECI). Credit conditions could be another factor. Finally, exhibit 19 shows that input prices, as well as the expected trend of input prices, are also important considerations when making purchasing decisions. Exhibit 16: Purchases of inputs index, April 2012 to March 2014 Exhibit 17: Purchases of inputs and new orders, January 2005 to March 2014 12
Exhibit 18: Purchases of inputs index and entrepreneur confidence index, January 2005 to March 2014 Exhibit 19: Purchases of inputs and prices of major inputs index, January 2005 to March 2014 13
7. Upstream cost pressure eased After staying above the 50-mark for six consecutive months, the input prices index dropped markedly from 52.6 in December to 49.2 in January. The index slid further to 47.7 in February and 44.4 in March, the lowest level since May last year. (Exhibit 20) The dissipating upstream cost pressure bodes well for manufacturers profit margins in coming months, as well as implies moderating inflationary expectations for downstream prices in the near and medium term. Exhibit 20: Input prices index, April 2012 to March 2014 Exhibit 21 shows that the input prices index is useful as a leading indicator of upstream prices. The input prices index generally leads the yoy growth of the purchaser price index of industrial products 3 by about 2 to 4 months. To show the association between the input prices index and midstream prices, we plot the input prices index against the yoy growth of the producer price index (PPI) 4 in exhibit 22. The yoy growth rates of both the purchaser price index and the PPI have been on downward trend since this year. Going forward, we expect the yoy growth of both the purchaser price index and the PPI to stay negative in coming months. We also forecast the CPI growth to hover around 2.3-2.8% yoy in 2Q14 and 3Q14. Finally, to see the extent to which input costs of Chinese manufacturers are affected by global commodity prices, exhibit 23 puts 3 The purchasing price index for raw material, fuel and power was renamed the purchaser price index of industrial products, effective from January 2011. The price index, compiled by the National Bureau of Statistics of China, measures the prices of production inputs such as raw materials, fuels and power, purchased by industrial enterprises. 4 The producer price index of industrial goods (PPI), compiled by China National Bureau of Statistics, measures the prices of industrial products when they are sold for the first time after production. 14
together the input prices index and the Thomson Reuters/ Jefferies CRB index. 5 Exhibit 21: Input prices index and purchaser price index of industrial products, January 2005 to March 2014 Exhibit 22: Input prices index and producer price index, January 2005 to March 2014 5 The Thomson Reuters/ Jefferies CRB Index, which comprises 19 commodities such as crude oil, aluminum, corn, cotton, gold, natural gas, soybeans, etc, has served as one of the most recognized measures of global commodities markets. 15
Exhibit 23: Input prices index and Thomson Reuters/ Jefferies CRB Index, January 2005 to March 2014, Thomson Reuters Exhibit 24 tries to give a convenient way of assessing and analyzing the profitability of Chinese manufacturers since new orders represent source of new revenue and input prices represent production cost. If the former rises faster than the latter, profitability tends to improve, and vice versa. In the past three months, the rise of new orders outpaced the rise of input prices, which bodes well for manufacturers profit margins in the coming future. Exhibit 24: Input prices and new orders, January 2005 to March 2014 16
8. Imports remained weak The imports index dipped through the critical 50-line again in December (49.0), only to go down further to 48.2 in January and 46.5 in February. In March, the index rebounded strongly to 49.1. Imports have continued to shrink, albeit at a slower pace. (Exhibit 25) The weak import performance was attributable to the decelerating purchases of inputs by Chinese manufacturers. We expect the imports index to rise above the 50-line in 2Q14. Exhibit 25: Imports index, April 2012 to March 2014 Exhibit 26 shows that the imports index is highly correlated (with some lags) to the import yoy growth rate. We expect import growth to stay modest at single-digit level in 2Q14 and 3Q14. Exhibit 27 illustrates the strong association between the imports index and the purchases of inputs index as currently around a quarter of China s imports are under the category of processing trade 6. Besides, China is a major importer of oil, iron ore and other raw materials. Finally, to see how heavily China s imports, or mainly imports of inputs, are affected by world commodity prices, we plot the imports index against the Thomson Reuters/ Jefferies CRB index. It is found that the imports index is positively related to global commodity prices. (Exhibit 28) 6 Processing trade refers to the business activity of importing all or part of the raw and auxiliary materials, parts and components, accessories, and packaging materials from abroad, and re-exporting the finished products after processing or assembling by enterprises within the Chinese Mainland. 17
Exhibit 26: Imports index and import growth, January 2005 to March 2014, China Customs Exhibit 27: Imports and purchases of inputs, January 2005 to March 2014 18
Exhibit 28: Imports index and Thomson Reuters/ Jefferies CRB Index, January 2005 to March 2014, Thomson Reuters 9. Employment index has fluctuated within a narrow range In the past few months, the employment index fluctuated within a narrow range. The index edged down from 48.7 in December to 48.2 in January and 48.0 in February, before rebounding slightly to 48.3 in March. (Exhibit 29) Note that the index has remained in the contractionary territory for twenty-two consecutive months. The slack labour market may help alleviate the wage pressure on Chinese manufacturers. Exhibit 29: Employment index, April 2012 to March 2014 19
Exhibit 30 proves that the employment in China s manufacturing sector has relied heavily on the export sector. Exhibit 31 and 32 give our readers some ideas about the extent to which the employment situation improves or deteriorates with the manufacturing sector and the overall economy. Exhibit 30: Employment and new export orders, January 2005 to March 2014 Exhibit 31: Employment index and headline PMI, January 2005 to March 2014 20
Exhibit 32: Employment index and real GDP growth, January 2005 to March 2014 10. Suppliers delivery slowed down The suppliers delivery time index stayed in the decelerating zone throughout January to March. The index dipped below the 50-line in January (49.8). It then gain 0.1 pts to 49.9 in February, before edging down to 49.8 in March. (Exhibit 33) Exhibit 33: Suppliers delivery time index, April 2012 to March 2014 21
11. Chinese manufacturers have become more optimistic The business expectations index, a new sub-index of the PMI introduced in January 2013, came in at 61.8 in February and 62.7 in March, up sharply from 51.3 in January. (See exhibit 34) Purchasing managers have become more optimistic about the near-term outlook for their respective industries. Exhibit 34: Business expectations index, October 2013 to March 2014 Oct 13 Nov Dec Jan 14 Feb Mar PMI: Business expectations 57.5 54.9 49.4 51.3 61.8 62.7 22
About China Manufacturing PMI: China Manufacturing Purchasing Managers Index (PMI) provides an early indication each month of economic activities in the Chinese manufacturing sector. It is jointly published by China Federation of Logistics & Purchasing (CFLP) and the National Bureau of Statistics (NBS). The Fung Business Intelligence Centre is responsible for drafting and disseminating the English PMI report. Every month questionnaires are sent to 3,000 manufacturing enterprises all over China. The data presented herein is compiled from the enterprises responses about their purchasing activities and supply situations. CFLP makes no representation regarding the data collection procedures, nor does it disclose any data of individual enterprises. The PMI should be compared to other economic data sources when used in decision-making. 3,000 manufacturing enterprises in 21 industries from Eastern, Northeastern, Central and Western China are surveyed. The sampling of the enterprises involves the use of Probability Proportional to Size Sampling (PPS), which means the selection of enterprises surveyed is largely based on each industry s contribution to GDP, and the representation of each geographical region. Survey responses reflect the change of each indicator, if any, in the current month compared to the previous month. There are 12 indicators in the survey: Output, New Orders, New Export Orders, Backlogs of Orders, Stocks of Finished Goods, Purchases of Inputs, Imports, Input Prices, Stocks of Major Inputs, Employment, Suppliers Delivery Time and Business Expectations. For each of the indicators, this report shows the percentage of enterprises reporting each response, the difference between the percentage of responses in the positive economic direction and the negative economic direction, and the diffusion index. The diffusion index is the sum of the positive responses plus a half of those responding the same. Diffusion indices have the properties of leading indicators and are convenient summary measures showing the prevailing direction of change and the scope of change. An index reading above 50 indicates an overall positive change in that variable; below 50, an overall negative change. The PMI is a composite index based on the seasonally adjusted diffusion indices for five of the indicators with varying weights: New Orders 30%; Output 25%; Employment 20%; Suppliers Delivery Time 15%; and Stocks of Major Inputs 10%. A PMI reading above 50 indicates an overall expansion in the manufacturing sector; below 50, an overall contraction. Currently there are 22 countries and regions conducting the PMI survey and compilation, based on an internationally standardized methodology. 23
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